EDITORIAL: Unbalanced economy: the problems ahead

by Peter Westmore

News Weekly, January 21, 2006

The Federal Government continues to be unconcerned about the dangers of Australia's debt-financed consumer binge.

At the beginning of 2006, it seems that everything is going right for the Federal Government. With its new majority in the Senate, it has secured the passage of industrial relations and student unionism legislation long rejected by the Senate, while the Treasurer, Mr Costello, was able to announce an expected budget surplus of $11.5 billion in the current financial year, $2.6 billion more than predicted in the May budget.

The Mid-Year Economic and Fiscal Outlook suggests economic growth is on track at three per cent for both this year and next. Unemployment reportedly remains around five per cent, the lowest official level for 30 years.

The Treasurer also predicted a surplus of almost $10 billion for the 2006-07 financial year.

But the Government's budget surplus, as well as the projected economic growth figures and low unemployment, are based on the continued inflow of huge volumes of capital from abroad.

If used for investment, capital inflows are beneficial to the economy, as they lay the foundation for further expansion of economic activity and therefore increased employment.

Consumption, not investment

There is deep concern, however, that a major part of Australia's capital inflows is directed to expanding consumption rather than investment, as reflected in the growth of private debt.

As the Melbourne Age editorialised after the Treasurer released his mid-year review, "While public debt has been slashed in recent years, it is countered by mounting private indebtedness and spiralling foreign debt. In the eyes of some commentators, private debt in Australia has already reached alarming proportions. The premium that was placed upon savings as recently as a couple of generations ago has largely dissipated ...

"Overall, Australia's foreign debt has steadily risen over the past three years by $140 billion and is predicted to increase by a further $50 billion over the current financial year."

While the Government has talked up Australia's export performance, the nation is running a growing balance of payments deficit, and exports are heavily dependent on commodities like natural gas, coal and iron ore to fuel China's rapid economic growth.

This has undoubtedly cushioned Australia from the normal consequences of a soaring foreign debt - a flight of capital as lenders seek a more secure country in which to park their money.

But when China's economy goes off the boil, either as a result of domestic constraints or because America or Europe cut China's massive export growth, Australia will be caught, as has happened in the past when commodity booms run their course.

There are strong reasons to believe that this will happen. The US threw open the door to Chinese imports, and as a result, the US balance of payments deficit last year was a staggering $US750 billion ($A1,000 billion), which is larger that the size of the Australian economy. Since then, Washington and Europe have both tried to curb Chinese imports.

The long period of growth of the Australian economy has obscured the fact that the past 15 years have been characterised by serious financial instability across the world, the adverse effects of which have by-passed Australia.

As Professor Bradford Long of the University of California has written, "The decade of the 1990s was marked by the sudden emergence of international financial crises. In a typical such crisis, a sudden loss of confidence in the value of a country's currency by international currency speculators was followed by a rapid rise in the value of foreign currency - in the exchange rate - the threat of large-scale bankruptcies of banks and firms, financial panic, and a sharp severe recession.

"These crises hit in the Mexican peso crisis of 1994-1995. Then followed the far-reaching East Asian crisis of 1997-1998. The decade ended with crises in Brazil, Turkey, and Argentina. Governments, central banks, and international organisations have spent the past half decade frantically trying to repair the flaws and plug up the institutional holes that generated these crises. But it is by no means certain that they have succeeded. We may well see more such crises in the future."

The Federal Government and its advisers apparently think it will not happen to us. Senator Nick Minchin said last month that the foreign debt was manageable, while the Secretary of the Treasury, Dr Ken Henry, argued that Australia's trade imbalance would correct itself, without damaging the economy. (The Australian, December 15, 2005).

Their optimism is touching, but to rely on the "invisible hand" is surely naïve. An active program to develop Australia's decaying infrastructure of transport and communications, protect small business and agriculture, and encourage Australian industry into import substitution, is far more important than running huge and unnecessary budget surpluses.